Thursday, May 17, 2012

FOMC Minutes: April 24-25 Meeting

Minutes for the last FOMC meeting are posted here. There are some interesting things here. The first is a discussion of how the FOMC might make its communications with the public even more complicated and confusing than they already are:

A staff presentation provided an overview of an exercise that explored individual participants' views on appropriate monetary policy responses under alternative economic scenarios. Committee participants discussed the potential value and drawbacks of this type of exercise for both internal deliberations and external communications about monetary policy. Possible benefits include helping to clarify the factors that individual participants judge most important in forming their views about the economic outlook and their assessments of appropriate monetary policy. Two potential limitations of this approach are that the scenario descriptions must by necessity be incomplete, and the practical range of scenarios that can be examined may be insufficient to be informative, given the degree of uncertainty surrounding possible outcomes. Some participants stated that exercises using alternative scenarios, with appropriate adjustments, could potentially be helpful for internal deliberations and, thus, should be explored further. However, no decision was made at this meeting regarding future exercises along these lines.

The idea seems to be to construct some "alternative economic scenarios." Who gets to choose those scenarios? How do we know that these scenarios are even consistent, i.e. how do we know that there is positive probability that such data could be generated by the US economy in the future? How do we know that the alternative scenarios cover the bases? What about big surprises? Would another financial crisis in the next year be a surprise?

Once the alternative scenarios have been laid out, each FOMC participant would presumably put his or her research staff to work evaluating what an optimal monetary policy response would be under each. Then we somehow aggregate this information and report it. Could this exercise actually be helpful? I doubt it, and apparently most of the committee seems to feel the same way.

Here's something I did not know:

With Mr. Lacker dissenting, the Committee agreed to extend the reciprocal currency (swap) arrangements with the Bank of Canada and the Banco de México for an additional year beginning in mid-December 2012; these arrangements are associated with the Federal Reserve's participation in the North American Framework Agreement of 1994. The arrangement with the Bank of Canada allows for cumulative drawings of up to $2 billion equivalent, and the arrangement with the Banco de México allows for cumulative drawings of up to $3 billion equivalent. The vote to renew the System's participation in these swap arrangements was taken at this meeting because a provision in the Framework Agreement requires each party to provide six months' prior notice of an intention to terminate its participation. Mr. Lacker dissented because of his opposition, as indicated at the January meeting, to foreign exchange market intervention by the Federal Reserve, which such swap arrangements might facilitate, and because of his opposition to direct lending to foreign central banks.

There is a special "North American Framework Agreement of 1994," governing swap arrangements with among North American central banks? What exactly did the signatories to this agreement have in mind? Have any swaps actually occurred under the agreement? Why does Lacker even care enough to dissent?

On forward guidance:

While almost all of the members agreed that the change in the outlook over the intermeeting period was insufficient to warrant an adjustment to the Committee's forward guidance, particularly given the uncertainty surrounding economic forecasts, it was noted that the forward guidance is conditional on economic developments and that the date given in the statement would be subject to revision should there be a significant change in the economic outlook.

This makes it clear, in line with what Fed officials have been telling us, that the forward guidance in the FOMC statement ("...likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.") can change. It is not a commitment. The interpretation is that, if the Fed's forecast changes, so will its forward guidance. Then, if we want to understand the Fed's policy rule, we need to have a view on what the Fed's forecast means. Is it objective, or just wishful thinking? What exactly will the Fed do if it gets a surprise? How much will the forward guidance change, and in response to what? How is the current forward guidance language somehow superior to the old language ("...low levels for the federal funds rate for an extended period.")?

FOMC members still believe that they have plenty of tools at their disposal:

The Committee also stated that it will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability. Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough.

To my dismay, these folks are convinced that quantitative easing actually does something. With the stock market going south, Europe in disarray, and a little less inflation, look for more QE at the next meeting, June 19-20.

"Either the government’s announcement is believed and the future is discounted immediately in the rate of exchange, in which case we suffer all the elements of a violent and sudden deflation; or else the government’s announcement is disbelieved, or only half believed, in which case we have a slow movement with the expectation of a further movement in the same direction, the effect of which on trade and employment hardly bears thinking about. As soon as the business world has good reason to believe that prices are likely to fall, no course is open to it except to contract its engagements, draw in its horns, and go out of business as far as may be until the funeste process is over…"

"In no other way than by the deliberate intensification of unemployment. The object of credit restriction… is to withdraw from employers the financial means to employ labour at the existing levels of prices and wages. The policy can only attain its end by intensifying unemployment without limit, until the workers are ready to accept the necessary reduction in money wages under the pressure of hard facts…. Deflation does not reduce wages ’automatically’. It reduces them by causing unemployment. The proper object of dear money is to check an incipient boom. Woe to those whose faith leads them to use it to aggravate a depression!"

If it was anything like the 2008 swap lines, then presumably the Fed wants to prevent the dollar and dollar rates from rising as a result of demand for USD from foreign banks who lose access to short-term, wholesale USD funding in times of crisis.

case a) QE does not work; case b) it does. I may assign a positive probability that it works, but whats actually relevant for planning is the probability that other people will assign to case (b): Even if i only assign a small probability to case (b) that QE works, if i am in a competitive industry I cannot afford to be wrong and lose market share therefore I will add a small amount of inventory consistent with my probability weighted expected forecast (and then you get a multiplier effect). If i am a bank with sophisticated models, those assumptions feed into my loss forecast models, and I update my capital and lending plan. etc etc.

I don't really have to have a strong opinion on each of the (for example) 9 "real" channels of monetary policy listed in the undergrad Mishkin text. Clearly the stock market goes up and inflation expectations go up so other people assign a positive probability.

As far as i am concerned, regardless of model uncertainty, as long as there is a sufficiently large number of people who assign a positive probability that QE works, then it works by affirming expectations and adjusting expected planning. Science may not be consensus, but expectations certainly are!

Good point. I could be wrong, but I don't think there are any deep secrets that aren't being revealed in speeches and in the FOMC minutes. The FOMC thinks QE works. Market participants believe it too. The way things are going in Europe and in asset markets makes it highly likely that more QE will be forthcoming. If I were you, I would go ahead.

"The way things are going in Europe and in asset markets makes it highly likely that more QE will be forthcoming. "

It's as if I never have to worry about the Dow falling more than 10% because some magical purchasing/twist program will be announced by the Fed and, for some reason or other, it will get stocks to rise again. I may as well anticipate this by buying the Dow when it's only fallen by 9%. But if everyone does this, the Dow will never fall by more than 9% and the Fed will never need to do QE. I may as well anticipate this and buy the Dow when it's only fallen by 8% etc etc. What an odd world.

"In addition, from the 1960s through 1998, the Fed had standing FX swap lines with several central banks, but their purpose was to provide currency for FX market intervention rather than to provide money market liquidity. Most of these older swap lines were phased out by mutual agreement in 1998, although Canada and Mexico retained small swap lines under the auspices of the North American Free Trade Agreement."

http://www.newyorkfed.org/research/current_issues/ci16-4.pdf

The Fed used a swap line to help support Mexico during the 1995 debt crisis, if I remember correctly.

We have seen two years of torched economic forecasts – and this unbalanced, stricken economy has yet to be hit by the bulk of the spending cuts. There is still no serious new framework in which innovative businesses can be built and financed. The Lib Dems are threatened with extinction as a national party, proper reward for complicity in such epic mistakes. The Tories should be no less concerned. Their capacity to exist outside the gilded constituencies of London and the south-east is under threat. In democracies, the neglected can hit back and hit back they will.

Stephen, let's make a couple bets. First, any clear hint from Bernanke that he is considering maybe doing more QE, and the stock market will rise immediately, as it has previously. (and, then, when the Chairman tamps down on those expectations, the market has fallen...) Second bet is that unless we get worse economic data, we won't see QE3. I'd say it's a longshot.

And, why do you think the great inflation you've been so worried about hasn't hit yet?